On May 10, 2005, the European Parliament voted to approve amendments to the cross-border merger directive proposed by the European Council in November 2004.1 The Tenth Company Law Directive on cross-border mergers (Tenth Directive)2 is aimed at eliminating regulatory barriers to international mergers of companies in the European Union.
More and more companies in the European Union transact business over national borders. The increasing globalization of markets and the growing integration of various facets of European Union member nations is compelling European companies to expand their business activities outside the geographical market of the national borders of their member state. However, current obstacles in national laws are impeding the natural economic progression of European companies.
At present, the merger laws of the individual member states are extremely fragmented and complex, and some even expressly prohibit cross-border mergers. These restrictive legislative conditions are forcing companies to resort to complex and costly alternative arrangements to achieve their business objectives, such as setting up holding companies to legally combine merging groups. Often, companies involved in cross-border transactions are forced to dissolve their legal entities in order to comply with complicated regulatory provisions of national laws. The costs and delays of such complex arrangements complicate expansion and, in many instances, make it practically impossible for small and medium sized companies to expand and remain competitive through mergers and reorganizations.
In an early attempt to provide relief to European companies facing these regulatory constraints, the European Commission adopted the Statute for a European Company.3 The Statute permits businesses to create a "European Company" or "SE" through a cross-border merger. The SE is a registered company of the European Union, rather than a registered company of any one member nation and, therefore, not subject to the limitations of national laws when combining. Under the SE Statute, however, only public companies in the European Union are permitted to form European Companies. Therefore, non-public small and medium sized companies continue to be faced with the daunting hurdles imposed by national laws impeding cross-border transactions.
The Tenth Directive would require that member states adopt regulations that would permit cross-border mergers for all companies, including non-public companies, that are structured with share capital. Therefore, the SE model would be expanded to allow even small and medium sized non-public companies, that until now were forced to operate within their national borders or within only a few member states, to expand through reorganization of their business outside of national borders.4
Although the Tenth Directive appears to have the current support of the member nations, the cross-border merger program of the European Commission has endured a long road of dissention and dispute. The first European cross-border merger initiative surfaced in 1984. While the initial European Council harmonization program appeared at first to be well received by the member states, concerns over the impact of cross-border mergers on the economies, employee rights and general national regulatory controls over strategic industries of member states stalled the implementation of the directive. In the more than twenty years that followed the original proposal of the harmonization program, the European Council, member states and expert groups appointed by the European Commission5 regularly met to address core areas of business law of the member states and to develop a modern framework for international merger regulation which would be acceptable to the member nations of the European Union. The result of these negotiations was presented in the European Commission Company Law Action Plan of May 2003.
The principal objectives of the Company Law Action Plan were to promote competition among European Union companies and strengthen shareholder rights, while at the same time safeguarding third party rights, such as employee rights.6 Although declared as a major objective of the Company Law Action Plan, the integration of employee participation safeguards may prove to be a major downfall to the successful implementation of the Tenth Directive. A significant impediment to the early adoption of cross-border merger legislation in the European Union involved issues relating to national employee protection measures of member states, including in merger transactions. The rule of employee participation in mergers is a foreign concept to United States companies, except in the limited context of restrictive provisions under collective bargaining agreements. However, employee safeguards, even in merger transactions, are a common factor in business operations of European companies. Faced with strong resistance form member sates and pressure from labor interest groups, the European Council proposed amendments to the Tenth Directive that would safeguard employee interests through mandated involvement by the establishment of representative employee groups to negotiate employee related issues in merger transactions. These protective measures under the Tenth Directive are extremely complex and could result in unexpected delays and constraints to proposed mergers of European companies. As a result, these requirements may end up having a chilling effect on European mergers.
Despite the anticipated complications of implementing the Tenth Directive, the cross-border merger program of the European Union could have a significant impact on United States companies with global interests. While the United States has historically been the leader in merger activities, recent mergers and acquisitions activity in the European Union demonstrates that there is great potential for value-creating deals within the European Union. As fragmented national economies merge into a real single market, European companies seeking to take advantage of growing markets for their products and services are seeking business partners to expand their businesses. As a result, the pace of European mergers and acquisitions activity is booming. In the first eight months in 2005, France surprisingly outpaced the United States in value of cross-border mergers and acquisitions activity.7 Given these trends, it is not surprising then, that the United States has come to realize the importance of establishing a free and open process of international mergers and taken steps to remain competitive with our counterparts across the seas.
Recognizing the importance of promoting the globalization of domestic operations, the United States Treasury Department has issued proposed regulations that would allow, among other things, tax-free treatment for cross-border mergers effectuated pursuant to foreign law.8 These regulations would level the playing field for United States companies and shareholders with foreign interests and foreign companies with substantial United States shareholder pools. Under the proposed regulations, a foreign corporation would have the ability to structure a tax-free acquisition of a domestic target corporation on the same terms as a domestic corporation acquiring a domestic target corporation. Currently, the only tax-free reorganizations available to a foreign acquirer of a domestic target corporation must meet more stringent standards that are structured as "stock" acquisitions which prohibit the use of any cash consideration, and "asset" acquisitions which allow the acquirer to provide cash consideration, or other "boot," of up to only 20 percent of the overall consideration. Under the proposed regulations, a foreign acquirer could effect an acquisition as a "statutory merger" and, therefore, could pay up to 50 percent of the purchase price as cash or other boot.
Under the current Internal Revenue Code regulations, the term "reorganization" includes a "statutory merger or consolidation." The current definition of a "statutory merger" requires that it be a transaction effectuated pursuant to the laws of the United States or the District of Columbia. Under the proposed regulations, the definition of a statutory merger would be amended to require a transaction to be effectuated pursuant to the statute or statutes necessary to effect the merger or consolidation, thus eliminating the requirement that the transaction be effectuated pursuant to domestic laws.
If adopted,9 the impact that the new Internal Revenue Code regulations likely will have on cross-border transactions will be significant, especially as the Tenth Directive is put into place by the member nations. As the established European Union SE entity begins to be adopted by pan European companies, and the European merger laws are unified, it is likely that a substantial increase in merger activity between the United States and the European Union member states will develop. In the face of less stringent regulations and the elimination of technical barriers to international mergers, European companies will face fewer legal obstacles to cross-border mergers and global companies will be able to structure their international merger transactions with more flexibility and economic efficiencies.
1 IP/05/551, Brussels, 10 May 2005;
2 Tenth Company Law Directive 90/434/EEG of July 23, 1990.
3 Statute for a European Company, No 2157/2001.
4 Under the Tenth Directive, companies involved in cross-border mergers would be governed by the laws of the member state to which they would be subject in a domestic merger which would be required to be consistent with the harmonization directives of the European Council in those transactions in which public companies are involved.
5 For example, the High Level Group of Company Law Experts appointed by the European Council to examine the modern regulatory framework for business law in Europe.
6 Protection would also be afforded to the interests of creditors, debenture holders, the holders of securities other than shares, and minority shareholders.
7 The Economist Global Agenda, September 6, 2005
8 §42 CFR 368(a)(1)(A)
9 A public hearing is scheduled in May to discuss the proposed regulations. The new rules will not take effect until the final regulations are published.
Published October 1, 2005.
